Monday, September 18, 2006

It had been discussed and hinted at for weeks and months, but it finally happened. The Russian Natural Resources Ministry and Environmental Department Rosprirodnadzor have revoked the permit authorizing Royal Dutch Shell's oil and gas development in Sakhalin. Waiting in the wings is the possibility of revoking Exxon Mobil and Total SA operating permits as well.

'It's symptomatic of the Russian industry to take control of key assets at as low a cost as possible,' said Craig Pennington, global leader of energy research at Schroders Plc in London. 'It's all part of the bargaining for assets up for grabs in Sakhalin-2.'

The Natural Resources Ministry in May urged Shell, Exxon and Total to cede more control of their ventures to Russian companies. Gazprom is in talks with Shell about swapping assets to acquire a stake in Sakhalin-2.

'We act in strict conformity with the PSA and Russian legislation and expect the Russian Federation to honor the PSA,' Ivan Chernyakhovsky, Sakhalin Energy spokesman, said before the decision. He declined to comment on the ministry's cancellation of the permit.

The ministry in May also told BP Plc's Russian venture, OAO TNK-BP holding, it must reach an accord with state-run OAO Gazprom to revive an $18 billion Siberian natural-gas venture. Gazprom is in talks to buy the 50 percent of TNK-BP that BP doesn't own, Vedomosti reported today, citing Gazprom officials.

If a nation wishes to manage and exploit its natural resources via state run operations, it is its right to do so. Certainly many other countries do this and it can be generally to the benefit of citizens in poorer nations (at least in theory).

However, to authorize private corporations to explore and develop oil and gas resources, and then pull those permits when they refuse to give in to apparent blackmail efforts by the government to gain a larger piece of the pie - is strictly amateur-hour criminal behavior. It unfortunately simply reinforces the impression of the Russian Federation as a shakey business partner and an undesirable place for foreign investment and development. Their inability to resolve the project issues by some other means calls into question the ability of foreign firms to develop petroleum reserves in Russia.

Now, my understanding of these contracts is that the Russian government would eventually get some percentage of the oil and gas reserves. The oil majors involved spend the money up front, get to recoup that development cost once production starts, and only then have to give over a percentage to the Russian government. So if $10 billion is spent to develop Sakhalin-2, the Russian government doesn't get its slice until after that cost is recovered by Royal Dutch Shell.

However, recently costs for Sakhalin-2 have been projected to have doubled to $20 billion. This is undoubtedly the underlying reason for the Russian government concern and desire to pull the permits on the project. This is the money game that is being played, and no doubt the Russian government is suspicous of cost overages and project accounting. On a project that size, they certainly should be suspicious. From the Dow Jones newswire report last week:

Russia's Minister of Natural Resources, Yuri Trutnev, said last week that enhanced environmental scrutiny of Sakhalin Energy is part of Russia's efforts " to defend its interests" after Shell announced that the cost of the project would nearly double to $20 billion.

The project is being developed through a special deal approved by Parliament known as a production-sharing agreement under which, in lieu of taxes, Russia takes part of the oil and gas produced once the investors' costs are covered. Doubling the cost of the project would mean Russia would have to wait longer to see its share of the profits.

Mitvol said his agency also expects a Russian court to hear a suit this week, brought by Rosprirodnadzor, which is aimed at canceling the permit. But Mitvol said the Ministry doesn't need a court decision to withdraw its approval.

Exxon's Sakhalin-1 project also recently had its budget increased from $17 billion to $12.8 billion, but because it has partnered at least in part with Rosneft, it appears to have escaped having the plug pulled ... so far. But continued cost overages are likely to have a similar response by the Russian government as the Royal Dutch Shell project.

If it were any other country, I would expect the final costs and the governments cut to be resolved fairly quickly so that the project can move forward. However, we are talking about the Russian government here - a government that seems to almost relish its reputation for unpredictability.Additional Headlines Regarding Sakhalin

In Tokyo, Shinzo Abe, who is expected next week to become prime minister of Japan, slammed Russia for suspending the Sakhalin II natural gas project, which is 45 percent owned by Japanese trade companies, saying that it would "damage relations between Russia and Japan."

The difficulties put in jeopardy contracts with Japan, South Korea and the United States on supplies of liquefied natural gas, which are due to go into effect in 2008. Two Japanese-backed companies - Mitsui Sakhalin Development (25%) and Mitsubishi-controlled Diamond Gas Sakhalin (20%) - are major shareholders in Sakhalin Energy.

Russian Minister Trutnev met Monday with Yasuo Saito, Japan's ambassador to Russia, and explained why his ministry had decided to backtrack on an environmental study into one of the country's biggest energy projects. The minister handed photographs ostensibly showing violations of environmental regulations during the project implementation.

"Recommendations were given three years ago, but they have still not been fulfilled," Trutnev said. "It could be argued that they have been implemented in part, but I want to remind you that we cannot preserve nature by half."

I could go on a lengthy rant about the whole idea of preserving nature, and man's role within nature. Suffice to say, I've never understood the idea that everything mankind does is unnatural or that there is any place on the globe that isn't affected by man's presence - particularly as we are part of nature to begin with. I'm all for conserving land, resources, wildlife - but the nature of such conversations and the language that is used, just really chafes my ass.

"Compromises must be sought on Sakhalin-2," Economic and Trade Minister German Gref said Tuesday, quoted by RIA Novosti news agency, referring to a 20-billion-dollar (15.8-billion-euro) oil and gas project off Russia's Pacific Coast.

"We cannot support all the proposals from investors connected to rising costs. It seems to me that they haven't been thoroughly worked out -- there's still more to work on," Gref said. Russia has strongly objected to Shell doubling its initial cost estimate of 10 billion dollars (7.9 billion euros) for developing Sakhalin-2 to 20 billion dollars. Russia said the cost overruns would deprive the state of billions of dollars in shared revenue it expects from the project.

Russia's ambassador to Japan said on Wednesday that Royal Dutch Shell's $20 billion (10.6 billion pound) oil and gas Sakhalin-2 project, which hit new environmental hurdles this week, could start operating early -- if Gazprom joined it.

Seeking to quell fears over late-stage objections to the project, which is due to supply large amount of natural gas to Japan from 2008, Ambassador Alexander Losyukov said Sakhalin-2 would move ahead and that he expected Shell to complete talks over selling a (20%) stake to state gas giant Gazprom by year's end.

He said Gazprom was a state-run company and if a state-run company joined the project it may be able to operate earlier. Losyukov ... said about half of 60 environmental violations remained unresolved.

"I do not see any reason to suspend the implementation of the [Sakhalin II] project until a revision of the feasibility study is complete," deputy economics minister Kirill Androsov said. "The state will conduct a new assessment, and the government will decide whether to include or exclude additional expenses in the revised feasibility study," Androsov said.

“It’s a strong sign that all the P.S.A. oil fields could be taken and given to the state,” said Konstantin V. Remchukov, the former member of Parliament. “They are dreaming up reasons” to renegotiate, he said.

On Tuesday, the economy minister, German O. Gref, said Russia would not cancel the deals, but he criticized cost overruns at the Shell project. Still, any revision of terms on the projects could have far-reaching consequences by positioning Russian state companies, rather than Western oil producers, as the beneficiaries of the strong energy market in the Pacific Rim.

“Times have changed in Russia,” Oleg V. Mitvol, deputy director of Rosprirodnadzor, the agency that revoked Shell’s license, said at a news conference here. “We want international investment, but we don’t want to be made into a banana republic.”

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